A Future-Oriented US Fiscal Policy

Glenn Hubbard
 Chicago skyline.


NEW YORK – At last, Republican candidates in the US presidential campaign have begun focusing on the economy. At a time of rising anxiety among middle-income voters about wealth inequality, and growing awareness of the unsustainability of Social Security and Medicare, this conversation could not be more important. Unfortunately, not enough attention is being paid to the link between these two key issues.
In fact, tackling the problems with Social Security and Medicare is the key to addressing what ails the middle class. But fiscal-policy progressives, in particular, remain fixated on using higher tax rates on the wealthy to fund higher incomes for everyone else.
Income redistribution may be an attractive idea for some – including, to a lesser extent, the Republicans who support a watered-down version, in which relatively high marginal tax rates support expanded family assistance – but it is fool’s gold. As a recent Brookings Institution paper shows, higher marginal tax rates would do little to diminish income inequality in the US.
Likewise, higher taxes cannot resolve the problem posed by the mounting unfunded liabilities of Social Security and Medicare. Maintaining these programs in their current form would require growth-destroying tax increases on middle-income Americans, as well as continuing cuts in government funding for defense, education, and research.
There is only one way to ensure broadly shared prosperity in the US: a future-oriented fiscal policy aimed at boosting employment and productivity, maintaining low marginal tax rates, strengthening support for workers, and investing in education, innovation, and infrastructure.

The alternative – allowing the past, in the form of interest payments on the national debt and entitlement spending, to continue dictating fiscal policy – would block prosperity among middle-income households, by requiring continuous tax increases and reduced public investment.
To fund this future-oriented policy, US leaders must implement reforms that enhance the long-run viability of the social safety net. As it stands, Social Security and Medicare are unsustainable, with the long-term gap between projected income and promised benefits reaching tens of trillions of dollars – well in excess of the official debt the federal government has accumulated over its history.
Closing the gap with tax hikes – the burden of which would be borne largely by middle-income households – would threaten both economic growth and living standards. And offsetting spending cuts provides no safety valve. Health care and Social Security already consume half of the US federal budget, up from one-sixth in 1965, and these outlays relative to GDP are projected to more than double by 2040. With no change in course, the programs’ “trust fund” balances will be depleted by the 2030s.
Avoiding that outcome will require US political leaders to constrain the growth of entitlement spending and bolster support for middle-income individuals. While Social Security and Medicare remain important to ensure wellbeing in retirement, their role must be updated to suit today’s needs.
For example, to ensure that no one who has worked for 30 or more years will live in poverty in old age, Social Security needs a higher minimum benefit for lower-income workers, with more affluent seniors seeing less growth in benefits over time. Adopting the chained consumer-price index for federal benefit calculations would ensure that benefits more accurately represent inflation, while slowing the rate of benefit growth for individuals.
Beyond stabilizing Social Security’s finances, US leaders should implement policies that place a higher value on work. Seniors working past the retirement age of 67 should not be subject to the payroll tax, and the retirement earnings test should be eliminated, so that seniors can work full-time without losing out on Social Security benefits. Finally, incentives for private retirement saving should be expanded.
A similarly honest and modern approach can also secure Medicare, without large tax increases on middle-income Americans. For starters, bipartisan proposals for premium support, with seniors receiving subsidies to purchase private health insurance, should be implemented.
To enable individuals to prepare to cover the associated deductibles and copayments, health savings accounts – funds which are not subject to income tax at the time of deposit, and can be used tax-free at any time to cover qualified medical expenses – should be expanded and strengthened. Premium support can significantly reduce Medicare spending, as it establishes a framework for more efficient spending on benefits, driven by competition and innovation in care and coverage.
So far, the only US presidential candidate who has recognized the need for such a future-oriented approach is former Florida Governor Jeb Bush, who has proposed modernizing reforms of Social Security and Medicare that avoid imposing high costs on middle-income Americans and a heavier debt burden on future generations. Two other Republican candidates, Ohio Governor John Kasich and Florida Senator Marco Rubio, have also raised constructive reform ideas.
By contrast, former Secretary of State and Democratic candidate Hillary Clinton and a leading Republican contender, Donald Trump, have opposed reform of Social Security and Medicare.

Senator Bernie Sanders, Clinton’s Democratic rival, actually proposes to expand the programs’ unfunded liabilities.
With so few presidential candidates recognizing the link between reforming Social Security and Medicare and ensuring broadly shared prosperity, the US faces serious risks. The progressive redistributive agenda could continue to advance, or the conservative entitlement-reform agenda could fail. Either way, the US would face growth-limiting tax increases and limits on the contributions that public investment can make to the country’s future.
There is a fiscal path to enhancing prosperity for middle-income Americans. It requires support for growth, rewards for work, investment in opportunity, and, unavoidably, reforms to Social Security and Medicare. One hopes that, as the campaign progresses, honest and forward-looking fiscal-policy debates recognizing this fundamental truth gain traction.

domingo, noviembre 29, 2015



Is Gold on the Verge of a Breakout?

By: Sol Palha

Hasten slowly and ye shall soon arrive. 

In August, we came out and openly stated in an article titled the Gold bull is dead that it was not the time to buy Gold. At that time, many analysts were calling for a bottom and much higher prices. We stated that there was a high probability that Gold would move lower before bottoming out. Fast forward and that outlook has come to pass.

So let's see what picture fundamentals paint.

Demand for Gold is soaring according to the World Gold council's latest report.

The latest report shows that overall worldwide demand for Gold soared by a whopping 33%.

Americans are jumping into the foray also; U.S retail demand for Gold soared to 32.7 metric Tons, 200% more than the same period last year.

The report also states that Gold demand in China Surged to by 70% to 52 metric tons.

Europeans also appear to be loading up on Gold. Demand increased by 35% to 61 metric tons.

So what gives; why are gold prices not soaring.

Based on fundamentals, the dollar should have crashed long ago, as the U.S. Fed has created more money in the last ten years than it has created in the last 100. Fundamentals would have had you jumping into energy and oil stocks just when they tanked. Up unit the very moment oil crashed, all the experts were screaming about a shortage of oil and surging demand in Asia.

Overall demand in Asia continues to rise, but the same individuals are now signing a different song. Instead of less oil, they are now singing the oversupply song; oh how fast they jump ship.

The following charts illustrate that Gold demand is increasing, so what gives?

Year-on-year changes in gold demand, by category

The chart from the world Gold Council clearly indicates that demand for this precious metal is rising.

Central Bank Gold Holdings

Central bankers are busy loading up on the metal. The main buyers are Russia and China.

Perhaps they are privy to information that the general public is not? Whatever, the reason, central bankers appear to be aggressively stocking up on Gold.

Consumer Demand for Gold in India

India has joined the bandwagon; Indians are buying a lot of Gold again.

Why or why when all the fundamentals look Good, does Gold continue to drop like a rock

Fundamentals do not drive the market; they just provide you with a picture to somewhat justify your biased views. What drives the market is emotions, and some technical indicators have the ability to pick up on these emotional changes. Crowd psychology is probably one of the best and least utilized tools when it comes to spotting topping and bottoming action. We are not talking about the timing the exact top or the exact bottom. This endeavor is best left to fools who have nothing better else to do with their precious time. Right now a lot of people are embracing Gold, but the crowd is still silent.

When the crowd joins the pack, then the situation will move from quiet to explosive.

The technical picture is indicating that a real bottom could be close at hand. In August, in article titled "The Gold bull is dead", we stated the following:

From the Technical analysis perspective, gold has one more leg down, but the last leg might or might not be too steep. Every bull market undergoes a back-breaking correction, and Gold is no exception.

What's next?

So far most of this has come to pass. Our trend indicator is not bullish yet, so until it turns bullish, Gold will not mount a significant rally. However, if you loved Gold at 1800, you should be simply nuts that it's trading at $1100. The Gold camp is in disarray and despair is beginning to set in; this is the ideal time for a bottom to take hold. When Gold topped back in 2011, the Gold camp was jubilant and could only envision higher prices. Gold is not the on the verge of a breakout yet, but it could be on the verge of putting in a bottom, and that would be a move in the right direction. To indicate that a bottom is in place, Gold cannot close below 1050 on a weekly basis; failure to hold above this level should lead to a test of the 1000 ranges, with a possible overshoot to $950.

A good idea plus capable men cannot fail; it is better than money in the bank.   
John Berry

Turkey has spent years allowing jihadist groups to flourish - so beware its real reasons for shooting down a Russian plane

Turkey has no interest in the peaceful settlement to the conflict in Syria that world powers are negotiating. As Erdogan gets desperate, he will attempt to bring focus back to Assad

Ranj Alaaldin @RanjAlaaldin

A trail of flames is seen behind the jet after it was struck by the Turkish military Getty Images

Turkey is getting desperate. Under President Recep Tayip Erdogan and his party, the Justice and Development Party (AKP), its policies toward the conflict in Syria over the past four years have been misguided and costly. When conflict broke out in 2011, Ankara mistakenly under-estimated the strength of the Assad regime and supported hardline Islamist groups seeking its downfall. In the process, Turkey also marginalised the Kurds and alienated regional powers like Iran.

Four years on, Assad looks set to hold onto power and his regime will be a central part of a transition plan, one that foreign powers were negotiating last weekend. Turkey’s regional rival, Iran, is a key player which can no longer be ignored by the West. Not only does the pro-Assad alliance now have Russian support firmly on its side, but the international community is no longer focused on defeating the regime – instead, it is concerned with defeating jihadist groups like Isis.

The shift in focus is a significant drawback for Erdogan. Years of support for, and investment in, Islamic fundamentalist groups like Jabhat al-Nusra (Al-Qaeda’s affiliate in Syria) and Ahrar al-Sham are about to go to waste. Ankara has played a significant role in allowing Isis and other jihadists to flourish in Syria and the region. Turkey has acquiesced to jihadist groups entering Syria via Turkey as well as their use of Turkey as a transit point for smuggling arms and funds into Syria.

The Kurds in Syria, meanwhile, have established themselves as a reliable Western ally and have created, in the process, an autonomous Kurdish region that has reinvigorated Kurdish nationalism in Turkey and across the region - much to Turkey’s dismay as it continues a brutal military campaign to repress the Kurds.

In other words, Turkey has no interest in the peaceful settlement to the conflict in Syria that world powers are negotiating. As it gets desperate, Turkey will attempt to bring focus back on the Assad regime and reverse the losses it has made both in Syria and geopolitically. The decision to bring down the Russian jet is, therefore, likely to have had other political factors behind it - particularly since the jet, as far as we know, posed no immediate threat to Turkey’s national security.

Domestically, Erdogan thrives on a climate of fear and uncertainty. This worked for him in the country’s snap elections earlier this month, during which he regained the majority he lost in June after months of bombings, violence and divisive rhetoric.

Ankara’s downing of the Russian jet may provide a useful diversion as it seeks to intensify its military campaign against the Kurds, particularly in the Kurdish-dominated Mardin province, where MPs were assaulted in recent days. Two days ago, Selahattin Demirtas, head of the pro-Kurdish People’s Democratic Party (HDP) who shot to international acclaim in the country’s national elections, survived an assassination attempt in Kurdish-dominated Diyarbakir.

These tactics will not be without long-term costs and will undermine the chances of peace in Syria as well as the West’s effort to defeat Isis.

The West appeased and bolstered Erdogan in Turkey in the run-up to the country’s elections, with the aim of securing a deal with Ankara on the refugee crisis. It may now regret that.

Erdogan is not only likely to drive a hard bargain but he may also walk away.

He has never cared much for the EU and has only sought engagement with the West when under pressure at home. But Turkey is not an indispensable ally and should not be considered as such. Unless the West starts to seriously exert pressure, Erdogan will have little incentive to stop his damaging policies.

Peak Debt, Peak Doubt, & Peak Double-Down

by Tyler Durden

Time to Hike Rates

It makes little sense to me why the market is only pricing a 6% probability of a rate hike at the October meeting, 30% for December, and only a near 50/50 probability all the way out to March 2016.  The statutory mandates of the Fed as stated in the Federal Reserve Act are “maximum employment, stable prices, and moderate long-term interest rates”.  All three have been fully realized.

The unemployment rate is 5.1% (full-employment).  Core CPI has been stable for years and printed 1.9% yesterday; remarkably close to the Fed’s self-imposed target of 2%.  For a few years, Treasury rates have been stable at near-historical low levels. In addition, the 4-week moving average of Unemployment Claims fell to its lowest level since 1973.  The most recent employment report was a bit weaker than expected, but it fell within a standard margin of error.  Yet, the Fed continues to remain at the emergency rate of 0.0%.

At the September meeting, the FOMC talked up the economy, but refrained again from hiking rates, citing “international developments”. By making this decision, the Fed has to be careful it does not also provide an ‘emerging markets put’.

As the October meeting approaches, international developments have settled down.  Emerging market stocks indexes and currencies have bounced since the September FOMC meeting. Chinese markets in particular have calmed down and have traded higher. The US stock market is higher. The trade-weighted dollar is lower. Credit spreads are tighter. The arguments for a hike at the October or December meeting should have increased not decreased.

The recalibration in rate hike probabilities could be the result of the “data dependent” language which has never been adequately defined.  It is suspect to believe that monetary policy for an $18 trillion complex global economy is being determined by a backward looking piece of monthly economic data.  Since Fed officials often cite the 24-month lag upon which monetary policy works, how can the Fed be both back-looking and forward-looking?  Thus, it is really about cumulative progress over time, not monthly data.

It is dangerous that over the last year or so, whenever an economic number is released that is slightly weaker than forecasts, moral hazard kicks-in with a full-steam-ahead risk-on market reaction.  Fed officials are ignoring this dynamic, but it should be a warning about ‘financial-instability’ and investor behavior.

Since that meeting, Fed officials continue to give mixed messages. Dudley, Brainard, Evans, and Kocherlakota suggest rates will not rise in 2015. Alternatively, Bullard, Lacker, Mester, Fischer, and most importantly Yellen, intimate ‘lift-off’ at the October or December meeting.

This divide is exacerbating market volatility. The sooner the FOMC speaks with a unified voice, the better for all.  Fortunately, clarity looms as the outcome is ultimately binary.


The best, but highest-risk, argument for risk-seekers is that the Fed may have generated a condition where it is trapped forever at the zero lower bound and must perpetually fuel a condition of ever-rising financial asset appreciation and credit expansion to prevent a catastrophe.

Moreover, the window to extract itself from this dangerous state might be closing. Let me explain.

One of my biggest concerns is the massive amounts of global indebtedness springing from the Fed’s low rate policy.  Low rates incentivize borrowing which in turn steals from future growth (particularly due to how the debt proceeds are being used).  As debt levels aggregate, a state of perpetual and exponential expansion in debt levels might be needed just to maintain the current state. In the early 1980’s, $4 of debt was needed to generate $1 of additional real GDP, but last decade it took $10 of additional credit, and since 2006, the amount has risen to $20. 

Is this the situation Hyman Minsky warned about in his “Financial Instability Hypothesis”? 

He described the impact of debt on the behavior of the financial system by defining three stages: “hedge”, “speculative” and “Ponzi financing”.  Growth and prosperity were initially created through early loans, which increase confidence and in turn drive speculation.  If and when higher rates slow revenue, the ability to pay principal and interest might be jeopardized, leading to Ponzi financing or default.

With large amounts of indebtedness, cash flow shortages could result in asset sales to meet obligations.  Since assets are typically used as collateral against debt, deflation could have the same result. Deflation lowers the value of assets, making liabilities harder to pay back as money due has less purchasing power.  This is the basis of Irving Fisher’s “Debt Deflation Theory”, a likely concern of the FOMC.

Where are we today?  Let me answer it this way.  Legendary investor Benjamin Graham distinguished the difference between investing and speculation by stating that an investment should afford, “Promises of safety of principal and a satisfactory return……operations not meeting these requirements are speculative”.

If the Fed is indeed worried about any of these dynamics, then waiting to extract itself from this state is only made more difficult by waiting.   The longer it waits, the greater the probability that it gets trapped in a powerful vortex from which the only way to extract itself is to allow economic destruction and massive debt defaults. The point of no return may have already passed.  Global indebtedness is at least three times what it was less than 10 years ago, and accelerating at a lofty pace.

What Should Investors Do?

Investors are too complacent (the Minsky-Moment).  Too many are still trying to profit from the Fed subsidy of past stimulus. Investors remain loaded in risk assets, incentivized by the need to beat peers and benchmarks and comforted into complacency by the Fed ‘put’. The true level of risk is being ignored.

The pervasive mentality of seeking maximum risk has become a terrible risk/reward trade for two main reasons.
  • Firstly, the Fed has fueled a massive stampede into financial assets, yet it can no longer provide any additional fuel in the form of interest rate cuts or via a growing balance sheet (QE4 will never happen). Promises of merely maintaining the current level of stimulus will be inadequate.
  • Secondly, high prices mean lower future returns and greater downside.  The fact that the Fed is close to ‘lift-off’, and close to shrinking its balance sheet (in 2016), means that downside risks are much greater than investors realize.  The herd has not yet adequately de-risked.
Let me deviate here as some of you may still be focused on my comment that “QE4 will never happen”. Let me explain it very simply.  The Fed is already under great scrutiny and criticism from many in Congress.  Should the Fed attempt QE4, Congress would likely try to re-structure the Fed; likely jeopardizing its independence.    In addition, the Fed does not want to ‘become’ the Treasury market (in spite of the Japan precedence).  The Fed is already hoarding over 40% of all outstanding Treasuries longer than 10 years; and, in doing so, it is having a major impact on the repo market.

The time has arrived for asset managers, and those who construct portfolios or control investment money, to shift exposures. Most portfolios’ exposures primarily consist of stocks and bonds, many with a ‘60/40’ mix as their starting point.  Adjustments typically take place through diversification and overlay factors consisting of variations in time, sector, and geography.  Unfortunately, stock and bond diversification alone will not be enough to adequately protect a portfolio during the years that follow zero rates and global QE programs.

Comments and a “to-do list”:
  1. It is time to find ways to preserve capital.  Return of capital strategies now trump return on capital pursuits. Particularly as uncertainties are growing due to:  disjointed and confusing Fed communication; an opaque Chinese slowdown;  the wild west of US politics and its elections; and EU refugees, to name a few. 
  2. Where possible, transition from financial to real assets.  As investors reduce beta and hidden beta exposures, consideration should be given to real assets, such as, real estate, farm land, collectables, art, and other non-correlated and less-cyclical assets.
  3. Cash has never had better optionality or a lower opportunity cost.
  4. I remain a bond bull in long Treasuries for regulatory, technical, and fundamental reasons.   As I have outlined in several earlier notes, long-dated Treasuries still remain an excellent place invest.
  5. Find companies and countries with low levels of debt and stable cash flows.
  6. Despite recent bad press, alternative investments should be considered.  Some specialized hedge funds are attractive, simply because they ‘hedge’ and are experts in a given areas.
  7. Place larger premium on market liquidity and counter-party risk.
Bottom line:  As a result of central bank actions, many assets today pose too much risk for too little return.
“Never delude yourself into thinking that you’re investing when you’re speculating.” - Benjamin Graham

Brazil’s Petrobras probe widens after arrest of billionaire banker

Authorities in Brazil opened a new frontier in the investigation into a vast bribes-for-contracts scheme at Petrobras this week when they arrested one of the country’s richest men at his Rio de Janeiro home after a raid at the investment bank he founded.

When federal police entered the São Paulo headquarters of billionaire financier André Esteves seeking documents relating to corruption at the state-owned oil company, they were surprised to learn he did not have his own private office: in keeping with the meritocratic culture of BTG Pactual, a darling of foreign investors, Mr Esteves sat at an ordinary desk in the middle of the trading floor.

“They insisted that he must have his own room and kept looking for it without any joy,” said a person who witnessed the scene.

Alongside Mr Esteves, prosecutors also arrested a sitting member of Brazil’s powerful senate — Delcídio Amaral, the leader in the upper house of the ruling Workers’ Party, or PT— for the first time in Brazil’s democratic history

The detention of the pair, who both deny any wrongdoing, brings the investigation for the first time directly into the world of Brazilian high finance and the upper echelons of the country’s political scene.

Until now, the Petrobras scandal has been mostly confined to the murky underworld of the oil and gas and construction industries, where former executives are alleged to have conspired with construction bosses, black market money dealers and politicians to extract an estimated R$6bn through fraudulent contracts.

The latest arrests could not have come at a worst time for left-leaning president Dilma Rousseff, who is struggling with twin economic and political crises as Latin America’s biggest country slips into what promises to be its worst recession since the 1930s.

For the president, who is also fighting an impeachment movement against her in congress, the arrests are a reminder that after 20 months the politically explosive investigation, which has already implicated nearly 50 mostly ruling coalition politicians, is far from over.
Indeed, if the group of elite young prosecutors, police and judges behind the probe into the scandal known in Portuguese as Lava J ato, or Car Wash, have their way, it may be only just beginning.

“We are trying to change the system here in Brazil so that the rule will not be impunity but will be a functional system that produces punishment when it is due,” said Deltan Dallagnol, one of the prosecutors leading the investigation. “We could have Lava Jatos all over the country.”

Those arrested include corporate grandees such as Marcelo Odebrecht, head of Brazil’s biggest construction group of the same name, in jail since June. Others include the treasurer of Ms Rousseff`s PT, João Vaccari Neto, and the former chief of staff of ex-president Luiz Inácio Lula da Silva, José Dirceu.
Aside from Mr Dallagnol and the team of prosecutors based in the southern city of Curitiba, the investigations are being led by a group of federal police, including Márcio Adriano Anselmo, the officer who first uncovered the corruption at Petrobras, as well as tax department investigators and a federal court judge, Sérgio Moro.

“There are groups inside the federal police and the MPF [federal prosecutors’ office] that are behaving in a very consistent way to change Brazil,” said Oscar Vilhena Vieira, dean of FGV Direito SP, a law school.

In September and October, analysts speculated that the Supreme Court was moving to diminish the influence of Curitiba over the investigation by redistributing those parts of the investigation not directly related to Petrobras to other cities, such as Rio, Brasília and São Paulo. The fear was these jurisdictions would be less rigorous in prosecuting wrongdoing.

Judge Moro responded by intensifying action on Petrobras, leading to this week’s arrests not only of Mr Esteves and Mr Amaral, but also of José Carlos Bumlai, a cattle rancher said to be close to Mr Lula da Silva.

“After the Supreme Court in October ‘decentralised’ the Lava Jato probe by delimiting the scope of investigations within it to only Petrobras, federal district court judge Sérgio Moro refocused investigations on the company,” said Eurasia Group, in a research note.

The concern for investors in Brazil is that the probe is moving ever closer to the core of the PT, threatening its main powerbroker, Mr Lula da Silva, and by default, Ms Rousseff, analysts say.

Senator Amaral was also close to the former president, Eurasia Group said. The more Mr Lula da Silva felt threatened, the more he would rally the PT’s far left. This in turn would jeopardise efforts by Ms Rousseff to implement a fiscal austerity programme which, while unpopular with the left, is widely seen as required to stem a widening budget deficit and stabilise Brazil`s economy.

“It’s a very bad scenario,” said Silvio Campos Neto, an economist at Tendências, a consultancy. He said his firm was predicting a contraction in GDP growth of 3.2 per cent this year and 2 per cent in 2016.

“Judging by the magnitude of the [Petrobras] process and the scope of the repercussions, it is expected to run throughout 2016,” he said, allotting a 30 per cent chance to Ms Rousseff being impeached.

If Mr Dallagnol has his way, the ramifications of the investigation will last much longer than just a year. The prosecutor said he and his peers are planning to petition congress to make important changes in laws that will make it harder for corrupt white-collar workers to get away with their crimes.

These include closing a loophole that allows white collar criminals to keep appealing in cases until they expire under Brazil`s statute of limitations, as well as increasing penalties.

Said Mr Dallagnol: “A person who commits corruption, he studies the cost and the benefits and here in Brazil you have a lot of benefits and you have no costs.”